This blog covers financial, political and other topics the author gets the urge to write about. It does not provide personal financial, legal or other advice. Consider consulting a personal professional adviser before making any decisions. Copyright (c) 2007, 2008, 2009, 2010, 2011, 2012, 2013, 2014, 2015, 2016, 2017, 2018, 2019 by Leonard W. Wang. All rights reserved.

Sunday, May 20, 2007

Why the Tortoise Ends Up Wealthier Than the Hare

Remember how the slow, steady, plodding tortoise of legend beat the swift but all too confident hare? When it comes to investment savings, the tortoise is also the winner. Here's why.

Research has shown that investors tend to chase returns. (See http://www.investopedia.com/articles/05/032905.asp.) When a market is hot and prices are skyrocketing, people tend to jump in. Often, they enter the market as prices are peaking, and then begin to take losses when the market falters. This happened to many investors in the late 1990's with high tech stocks, and more recently to many buyers in the real estate markets (many of whom exacerbated their problems with high risk loans).

Then, the same investors that plunged into the market when it was rising tended to sell when it declined. They were therefore not invested when the market began to recover, and missed out on the gains that the recovery offered.

The end result is that many investors buy high and sell low. This isn't a way to make money.

What leads people to chase returns like this? From a psychological standpoint, it's unclear. But the financial phenomenon that triggers buying high and selling low is market volatility. That is to say, the tendency of a market or investment to rise or fall rapidly. The faster the market or investment rises, the more it lures people in. The harder it falls, the more likely they will flee. But they aren't making a lot of money this way.

How does an ordinary investor combat the tendency to chase returns? By seeking out more stable investments. The less your investments create false hopes or major gastronomic distress, the more likely you are to stay with them and capture long term gains. You shouldn't embrace risk--too much of it is likely to lead y0u to buy high and sell low. Instead, you should take conservative, calculated risks--enough to have the potential for long term gains from stocks, but with some stable assets like bonds, bank or credit union certificates of deposit, or money market funds to keep you from abruptly exiting the financial markets and putting the money in a mattress.

Perhaps it's counterintuitive to invest in a way that limits your potential for big investment gains. But recognize that we're all human, invest in a way that saves us from ourselves, and you may end up winning the tortoise's victory over the hare.

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